A Little Theory
So I’m not going into much detail on this, but I’ve developed myself a theory on the current potential for a recession. This probably isn’t original; I’m sure many others have thought of it, too. But I haven’t seen it much thus far. Many politicians will try to blame Bush, Clinton, or the respective parties for the previous and the current potential recessions, others blame September 11th (which happened towards the end of the recession) but I blame Alan Greenspan and the Fed.
As you all know, we try to raise the money supply in such a way that it corresponds with economic growth to result in (relatively) stable prices. (MV=PY) This policy typically works fairly well, especially in light of other options, but this policy fails when there is a boost in total factor productivity. Similarly, the gold standard was normally a good standard because usually gold grew at about the same as the economy. Gold tended to stress the economy when our economy boomed and gold wasn’t keeping up. (And there is good debate to which system works better.) But back to my point, in the 90s, we had a boost in total factor productivity which made our economy grow faster than usual. (http://www.boj.or.jp/en/type/ronbun/ron/wps/kako/data/iwp03e01.pdf) The Feds response was to keep money growing in an equal pace to keep prices constant, which led to a period of “easy money.” Not only did this cause the economy to outgrow itself, but this also allowed people to make bad loans and take on excessive risk. (Thus the housing market today.) So when the total factor productivity growth slowed in 2000 (ibid), it put enough pressure to cause the first recession and continues to have impacts today.
What the Fed should have done is to allow deflation. I guess George Selgin rubbed off on me a little.
“My main theme is that deflation isn’t always a bad thing, and that it can even contribute to overall macroeconomic stability so long as the rate of deflation mirrors the rate of productivity growth. (It is also desirable for prices to rise when productivity suffers a setback, so my argument is for deflation in good times only.) Many of today’s monetary theorists and central bankers reject this viewpoint, holding instead that monetary policy should aim at a more-or-less constant price level. In my opinion, arguments for a constant price level or “zero inflation” fail to come to grips with the implications of productivity changes, which these arguments tend to ignore.” - Dr. Selgin, http://www.terry.uga.edu/~selgin/ (Also see the picture of Penelope there.) So basically, the Fed pushed too much money out there which caused a period of real strong growth, but in the long run leads to our current instability.
This is all speaking off the cuff, but it sounds pretty good to me and makes sense. I haven’t put too much effort into it, but wondering what you’re thoughts are on this subject.
